The Fed Brought A Knife to a Gunfight

Posted: Jul 26, 2012 12:01 AM

Over the course of the past year, I have advocated the view that the Federal Reserve is out of bullets. All the central bankers of the world are out of bullets. They don’t have any ammo in their back pocket to reload.

The entire EU is overwhelmed with government debt. Greece is running out of money due to entitlements, and France has turned socialist. Germany cannot save the EU by itself, and the entire region is spinning into recession. No doubt, it will have a hard landing.

China is slowing. The EU is one of their better customers and can’t afford to buy anything anymore. Not only is the EU a problem, but internally they have misallocated assets creating artificial wealth. That inflated value will have to deflate, deleverage and drop in price. Somewhere, Jimmy Chanos is smiling.

In the US, the Federal Reserve has tried everything in its entire bucket list to try and help the economy. Quantitative and qualitative easing hasn’t helped. It’s only decreased the value of the dollar and made American portfolios look better. Everyone feels wealthier, but the reality is they aren’t. TALF, TARP are both failed programs. They kept the banks afloat, but there is no turnover of the money the Fed created. No velocity. Money gets printed and then sits on bank balance sheets.

After all that failure, the Fed tried Operation Twist. Not seen since the early sixties, Operation Twist is where the Fed sells short term securities and buys long term securities. This artificially lowers long term rates, flattens the yield curve and is supposed to be stimulative for monetary policy. Operation Twist failed.

The rumor around market watchers now is that the Fed will engage a new round of Quantitative Ease. QE3. It will fail too. Japan has tried to stimulate its economy for over two decades using central bank monetary policy. It hasn’t worked.

The Fed really can’t do anything. It can just mind its p’s and q’s and watch. If we want to stimulate the economy, the only body that can really make anything happen is Congress. However, Democrats and Republicans are at odds over both economic and tax policy, so we will have to be like all Chicago Cubs fans and wait until next year for something to happen.

For the Democrats, I would suggest reading this study on the effect of tax decreases and multiplier effects through the economy. Then, undo the entire magazine of regulatory damage that they have thrown into the economy since 2008. Unshackle businessmen, and let them take over.